Despite rising interest rates, bank stocks are still a risky bet

Despite rising interest rates, bank stocks are still a risky bet

The KBW Banking Index, up 35% in 2021, is now down more than 13%, despite strong consumer spending and rising interest rates

JPMorgan CEO Jamie Dimon sees an economic "storm" ahead
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One of the hottest deals in the market since the COVID-19 outbreak in 2020, the US banking segment, appears to have turned for the worse this year. After gaining 35% in 2021, the KBW Bank index is now down more than 12% so far.

Industry losses were led by some of the biggest lenders in the market, with Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM) down about 17%.

In theory, this drop makes banks thrive as the central bank raises interest rates due to higher income from lending, mortgage and credit card debt products.

For example, the last time the Federal Reserve started raising interest rates in late 2015, bank stocks have outperformed the S&P 500 significantly over the next two years.

However, now that we're starting what many believe will be one of the most dramatic monetary tightening yet, bank stocks are falling. So why are investors dumping the sector?

One explanation is that recession risks could remove much of the growth engine for banks and neutralize the boost from higher interest rates. In this scenario, interest rates are going up, but consumers and businesses are either struggling, or they don't borrow as much with the risk of default more often.

"Storm" is ahead
The warning for such a frightening prospect came not from anyone else but from the banks themselves. JPMorgan CEO Jamie Dimon yesterday warned investors to prepare for an economic "storm" as the economy faces challenges, including tightening monetary policy. and the Russian invasion of Ukraine.

Dimon said at a conference sponsored by AllianceBerntein Holdings on Wednesday:

“That storm is threatening us. We don't know if its scale is small or large. You'd better be prepared for good news."

There are also signs that lenders are struggling to boost earnings after several quarters of strong growth. Bank of America in April reported a 12% drop in first-quarter profit, followed by JPMorgan, Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) - all of which reported first-quarter earnings declines of two numbers. All but Bank of America reported lower revenue.
The execution of the deals gave power to investment bankers. After a two-year pandemic-related hiatus, the final quarter is set to return to normal for US banks. Instead, Russia's invasion of Ukraine also created new barriers to the global economy's path to pandemic recovery, boosting stock trading and commodity markets.

As a result of those results, Morgan Stanley strategists recently downgraded the entire financial sector at the end of March, asking investors to prepare for slower US growth.

The bottom line is that consumers and businesses appear to remain financially healthy. Lending at many banks increased in the first quarter, a welcome change after two years of sluggish demand during the pandemic. Bank of America, the largest U.S. bank, sees increased demand for loans for new and existing credit products.
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